‘There are obviously lessons to be learned,’ said Bank of England Governor Andrew Bailey at today’s House of Lords Economic Affairs Committee. It was a point he repeated many times over, in reference to the inflation crisis that has plagued Britain for close to two years now. ‘We have to learn lessons from the experiences we’ve had, of course we must… We have to work out what those lessons are.’
But despite repeating this sentiment over and over again, Bailey could not meaningfully come up with one good example of such a lesson, nor could he go into much detail on the mistakes the Monetary Policy Committee has made over the past two years. Pressed multiple times by the committee about the Bank’s handling of rising prices – and its slow action on interest rates – Bailey simply kept insisting that hindsight could not be used to judge decisions that were made in the moment. ‘Rerun the evidence’ at the time he said, but don’t apply today’s knowledge to yesterday’s decision-making.
The problem for Bailey is that the evidence was there back in 2021 – the year he says the MPC found most difficult to judge – that prices were going to rise. Then-chancellor Rishi Sunak knew it. Bailey’s outgoing chief economist knew it. Bailey insisted that the evidence only started coming to light, about just how tight the UK labour market was, in ‘November 2021, a little bit before Ukraine, but not that much.’ But job vacancies had already hit a record high – over one million – by July. And the headline inflation rate was more than double the Bank’s target by November. In the closest moment to admitting to a real mistake today, Bailey explained that ‘we thought unemployment would rise,’ leading to his theory that all of this was simply ‘transitory’. ‘We were wrong, frankly.’ Very wrong, indeed.
Bailey was giving evidence to the Lords this afternoon, primarily to discuss the central bank’s independence. Structures and regulatory issues were all brought up – but it was not an especially onerous topic, not least because no one is seriously arguing that monetary tools should be returned to parliament. Even at the height of Liz Truss’s criticisms of the Bank last summer – putting pressure on the Monetary Policy Committee to hike rates – the former prime minister never budged from a pro-independent position on the Bank. Rishi Sunak and his chancellor Jeremy Hunt tend to be even more cautious, refusing to get pulled into any kind of discussion involving monetary policy.
So the conversation veered, as it often does these days, to the crippling issue of inflation, as the rate has fallen this year at a far slower pace than the Bank expected. The most methodical questioning came from Lord Mervyn King – a former governor – who step by step questioned Bailey about the Bank’s own role in contributing to inflation: the huge inflation in the money supply.
‘Tell us a bit more about the monetary side to it,’ King requested, ‘because it’s not easy, in the Monetary Policy reports to see much reference to that.’ It’s a point that’s been highlighted on Coffee House many times this year: that the MPC likes put emphasis on external shocks to the economy, including supply chain breakdowns, the war in Ukraine and the tight labour market, but ultimately inflation is a monetary phenomenon, yet such substantial money-printing during the pandemic is never voluntarily brought up by the bank.
Lord Griffiths put it bluntly: ‘You talk about the supply-side shocks,’ he said to Bailey, but ‘all of those supply-side shocks are outside of the Bank of England. Money supply is ‘‘in the control of the Bank of England, but is somehow not mentioned.’ Bailey ceded this as a ‘fair’ point to make.
Today’s evidence session will have persuaded virtually no one that the Bank and its governor take responsibility for the many consequences of sky-high inflation
Perhaps the biggest area of agreement between the former and current governor was the deep problem with the Bank’s models, which they broadly agreed don’t work. ‘It doesn’t really matter what you do,’ said King, in regards to the inputs, ‘inflation in the medium term always comes back to 2 per cent.’ Bailey insisted he was ‘absolutely correct,’ which explains their ‘biggest ever upside skew’ on inflation risk – to take into account that to follow the models right now would be to seriously underestimate the severity of the current crisis.
And it’s a crisis that continues to have knock-on effects. With the labour market still extremely tight, and core inflation actually rising on the year in April, the expectation for peak interest rates is coming close to 6 per cent, up from 4.5 per cent now. This is driving up UK borrowing costs, as these expectations rise, taking two-year gilt yields up to 4.8 per cent today – higher than last year’s mini-Budget (albeit for very different reasons).
Today’s evidence session will have persuaded virtually no one that the Bank and its governor take responsibility for the many consequences of sky-high inflation. In this sense, nothing has changed – despite what seems to be increasing nervousness and volatility in the markets.
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